United Fire & Casualty Company v. Fidelity Title Insurance Company, et al, No. 00-2595(United States Court of Appeals, 8th Circuit, July 16, 2001)

A title agent made an error insuring over a recorded “Notice of Adverse Claim” filed by Rockford State Bank to establish priority for an unrecorded mortgage it held. The borrower applied for another loan with Southern Pacific Mortgage, which the Agent believed would have priority over the unrecorded Rockford State Bank loan. Borrower claimed the Rockford loan was never intended to be a lien on the property and was secured by a trust fund in which Borrower was the beneficiary.

At the Southern Pacific closing, $5,000 was held in escrow to initiate legal proceedings to extinguish Rockford’s “Notice of Adverse Claim” if necessary. Prior to closing, Agent contacted Title Carrier about the “Notice of Adverse Claim” but closed the transaction before receiving authorization from the Carrier.

After closing the Agent issued a lender policy insuring Southern in first position with no exception or reference to the Rockford mortgage. Agent's decision to insure over the "Notice" was a bad one – a court ruled the Rockford mortgage had priority over Southern. Title Carrier paid out $365,000 then sued Agent believing recovery would be a slam-dunk.

Agent did not miss the “Notice of Adverse Claim” in his search. Instead, he decided to make his own underwriting decision based upon conversations with others and his own knowledge of the law. He closed without the blessing of Title Carrier. The Agent’s E&O carrier denied the claim relying upon the following exclusion:

“to claims arising from defects in title of which the Named    Insured had knowledge at the date of issuance of such title  insurance.”

The E&O carrier prevailed on Summary Judgment, which decision was upheld on appeal. The court believed the policy was intended to provide coverage for negligent title examinations, but not defects that Agent knows about and then makes an error in insuring over.

“Agent knew the Notice of Adverse Claim could only be removed by litigation, since he set aside $5,000 in escrow to pay attorney’s fees necessary to conduct the litigation. In addition, he knew about the Notice at the time he issued the title policy. The exclusion for ‘claims arising from defects in title of which the Named insured had knowledge at the date of issuance of such title insurance’ applies.”

“We disagree with appellants’ contention that interpreting the policy in this manner renders the E&O coverage illusory. The doctrine of illusory coverage applies only when “part of the premium is specifically allocated to a particular type or period of coverage and that coverage turns out to be functionally nonexistent.” That is not the case here. The E&O policy clearly provided coverage under many circumstances. But the policy was not meant to provide coverage for known defects in title.

An E&O Policy insuring an agent must cover the complete scope of the agent’s business activities, which includes title examinations, closing duties and underwriting decisions. In this case, the E&O Carrier successfully limited its’ policy to a negligent title examination, which is, typically, just missing a document of public record. The court found that a separate or additional premium was not paid to cover negligent underwriting decisions by the agent, which is an entirely different risk than missing a document in a title examination.

Agents must understand that they need complete title agent coverage. The minimum coverage is for negligent title examinations, which would leave a title agent uninsured for closing activities and underwriting decisions.

Look at your E&O Policy each year so that you can negotiate coverages suitable for the nature of your practice.